Global Economics

A Low Season for Low-Cost Airlines?

It's still chaos everywhere you look at British airports, and no one is feeling the strain more than Europe's fast-growing budget airlines. Since the terrorism scare unfolded on Aug. 10, British low-cost carrier EasyJet has canceled more than 500 flights, while Europe's largest discounter, Ireland's Ryanair (RYAAY), has grounded 270 of its 750 scheduled daily departures.

The situation has gotten so bad at Ryanair's main British airport, Stansted, that the carrier is considering suing the British government. "The new security rules are nonsensical and ineffective, and the government's handling of the crisis is worse than the Keystone Cops," says Ryanair CEO Michael O'Leary. "This cannot become the norm, or the terrorists have won."

PHYSICALLY IMPOSSIBLE. The security threat is costing the entire British airline industry millions, but budget carriers are more vulnerable than others. That's because the low-cost airlines' business model depends on getting planes back in the air just 25 to 30 minutes after landing.

But with new security measures leading to lengthy delays, such targets are difficult to maintain. "It makes it almost physically impossible for these carriers to turn the aircrafts around as quickly, meaning they can't operate as many flights," says David Bryon, an industry consultant and former managing director of British budget carrier bmibaby. "Every day an aircraft sits on the ground costs the airline as much as $190,000 in lost revenues."

The new limits on carry-on luggage are also likely to add to the delays and costs. Not only will it now take longer to load and unload the plane but the carriers will need additional staff to do it. The new rules undermine budget carriers' efforts to get customers to travel with only carry-on luggage in order to speed up turnaround times and reduce baggage handling costs.

CHECKED BAGS. Ryanair figures it can halve waiting time at airports and shave $38 million off costs by getting passengers to check in online and travel with only carry-on luggage. In January it introduced charges of up to $9.50 for each bag checked in the hold.

It's all part of the airline's strategy to keep fares low and make up the difference with additional services such as in-flight food and drinks. Those types of ancillary revenues totaled $331 million for Ryanair last year. But now that airport authorities are requiring passengers to check all but the smallest bags, Ryanair is temporarily waiving the charges for passengers checking in bags at the gate.

For Ryanair and Easyjet, the new airport measures threaten to pinch profits, but not fatally. Ryanair, now Europe's largest and most profitable airline, with 42 million passengers and profits of $472 million, is strongest of all. Still, both carriers face up to $19 million each in lost revenue, which could shave profits an estimated 5% to 7%, says Andrew Fitchie, an analyst with London brokerage Collins Stewart.

VULNERABLE PLAYERS? For the smaller, newer carriers, the risks are more ominous. More than 40 upstarts, such as SkyEurope and Hungary's Wizz, have emerged in the Past two years, inspired by the success of Ryanair.

But as fuel and now security costs rise, some analysts expect a shakeout. "This latest shock to the industry will weed out the weaker players," says Joe Gill, research director for Goodbody Stockbrokers in Dublin.

Financially stretched, these newer carriers, especially, are dependent upon the peak summer travel season to survive. For many budget carriers, whose customers are mainly leisure travelers, the period between June and September can account for as much as 65% of annual profits. If the chaos continues, some weaker players could end up finding themselves out of business.

For now, the security crackdown is limited to British airports. But that could quickly change. European Union officials are meeting this week to discuss airport security measures in the wake of last week's events.

If the measures were extended across Europe, analysts say, the added delays and higher ticket prices could turn off customers to short-haul carriers. "Short-term, the financial consequences are manageable," says Gill. "It's the potential impact these restrictions may have on longer-term demand that is more worrying." For Europe's fledgling discount carriers, that's a big worry indeed.